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Ramping up interest rates won’t quash inflation

By Terry Ryder
07 February 2023 | 13 minute read
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I find it quite startling that no one in this country questions the prevailing theory that the best way — indeed the only way — to fight inflation is to increase every mortgage holder’s interest rates.

Everyone, including economists, politicians, journalists and the general public, seems to blindly accept that constantly lifting interest rates is the thing to do when inflation is high.

I believe there’s a strong case that the conventional wisdom — if indeed it is wisdom — is questionable in the current circumstances and that Australian families are being slugged with massively higher lending costs for no good reason.

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There are other better ways to deal with the key components of the current high inflation rate given higher interest rates are not having the forecast effect.

To date, we have had eight, rapid-fire interest rate rises by the Reserve Bank (RBA) which has panicked, after earlier getting it horribly wrong with their predictions about inflation and interest rates.

The official interest rate has risen from 0.1 per cent to 3.1 per cent at record speed, with home owners now paying 5 per cent to 6 per cent on their mortgages.

But there has been no visible impact on the rate of inflation, which continues to rise.

So, what will the RBA do in response to the reality that lifting interest rates hasn’t brought down inflation? They will lift interest rates again.

Sadly, that’s all they have in their box of tricks. No Plan B, no alternative policy — just ramp up interest rates.

The RBA governor Philip Lowe has no other ideas to offer it seems.

What he’s doing fits that popular definition of insanity, doesn’t it? Insanity is defined as doing the same thing over and over again, but expecting a different result even though what you’re doing is clearly not working.

But an examination of the key elements causing the high inflation rate suggests strongly that higher interest rates will have little or no impact.

The official data shows that the key components of the high inflation rate are petrol prices, housing construction costs, and the price of fruit and vegetables.

None of these situations has been caused by demand from Australian consumers spending wildly and pushing up prices.

They’ve all been caused by a set of peculiar special circumstances beyond the influence of consumers.

High petrol prices are fundamentally being caused by the war in Ukraine. They’re up 16.6 per cent in the past 12 months. Lifting the interest rates paid by Australian families won’t end the Russian invasion of Ukraine and it won’t reduce the price of petrol.

Every litre of petrol we buy includes about 46¢ in taxes to the federal government; so to fight inflation, the government should reduce or scrap the fuel excise until global prices come down.

Rapidly rising costs in the home construction industry are the result of shortages of core materials and tradespeople, which is a product of the pandemic and the disruption to supply chains. Construction costs have soared in the past 12 to 18 months — up 18 per cent in 12 months — and lifting interest rates will likely make it worse, not better.

The federal government could introduce measures to address these skills shortages and while waiting for that to take effect, reduce the tax take which inflates the price of new house-and-land packages, with research indicating that up to 50 per cent of the cost of new housing is government taxes, fees, and charges.

Soaring residential rentals are also adding massively to living costs and this is something the federal government can dramatically influence by providing incentives to investors, rather than the disincentives that have accumulated over the past five to six years that has helped to create the current rental crisis.

Food prices have also risen because of shortages caused primarily by extreme weather events, as well as pandemic issues. Again, lifting interest rates won’t fix the food supply shortages and prices will remain high.

Clearly, there are measures that the federal government could take to address the shortages that are causing the prices of these key items to increase.

But our politicians appear to be as bereft of ideas as our economists are and they’re sitting back and leaving it to the RBA to deal with inflation.

But sadly, the RBA has just one tool in their kit bag, lift interest rates even though that measure does nothing to address the true causes of the high inflation rate we currently have.

And when that doesn’t work, they’ll go to their “alternative” strategy, which is to lift interest rates more.

It’s time this blinkered, simplistic and ineffective approach was challenged and that we consider the possibility that perhaps there’s a better way.

Terry Ryder is the director of Hotspotting

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